Pretty much every basic materials industry is fraught with periods of boom & bust. Today, the energy sector seems to be going through one of those “bust” periods. Prices for crude oil have shrunk about 50% over the last 7 months or so as supplies continue to outstrip demand.
That drop in oil & natural gas prices has crimped earnings and share prices for a variety of energy stocks, both large and small. Which brings us to the next part of the “bust” cycle — increased merger and buyout activity.
Already, we’ve begun to see the beginnings of major M&A activity in the energy sector, with a few major deals already announced.
For investors, the increase in M&A offers an opportunity to profit, and two different oil ETFs could be the best plays on all the deal making.
Huge Deals Boost Oil ETFs
Since prices for crude oil plunged and hit a six-year low back in March, the energy sector has been humming along with a variety of big-time deal making.
We’ve already seen Royal Dutch Shell plc (ADR) (NYSE:RDS.A) write a huge check for $70 billion to snatch up natural gas producer/exporter BG Group. We’ve also seen pipeline firm Williams Companies Inc (NYSE:WMB) swallow its own master limited partnership (MLP).
And more M&A activity could be in store for the next year or so. That’s because the combination of slightly rising oil prices and more certainty around individual company valuations have placed a price floor on the sector, making it far easier to get deals done.
According to data provided by news agency Thomson Reuters, 40 energy firms have raised roughly $18.7 billion with new share offerings over the past four months, while 35 issued around $26.4 billion in new debt. Those additional share sales are the highest amount recorded over the last 15 years.
All of this will help support rising M&A over the next year and create a very dynamic market for buyout activity. To quote energy analysts at Citigroup, “the dam will break.”
PowerShares S&P SmallCap Energy Portfolio (PSCE)
For investors, there are some ways to capitalize on rising M&A activity. You could try and guess who is going to be next and buy shares of some individual small or mid-cap producers … maybe you’ll make some money that way.
However, making a broader bet using oil ETFs is a much better idea — especially if you pick oil ETFs that focus on the smaller end of spectrum. Take the PowerShares S&P SmallCap Energy Portfolio ETF (NASDAQ:PSCE) for starters.
This oil ETF tracks all the energy stocks in the S&P SmallCap 600 Index and features a who’s who of wildcatters, shale producers, fracking firms and smaller oil services stocks. These are the firms with reserves in the ground and are exactly who the larger energy firms are looking at adding during this new wave of M&A. Top holdings include PDC Energy Inc (NASDAQ:PDCE) and Carrizo Oil & Gas, Inc. (NASDAQ:CRZO). All in all, PSEC holds 35 different energy stocks.
As far as returns have gone, PSCE has been a mixed bag. In the past year, the oil ETF has lost about 45%. However, that makes it an interesting value for investors looking to get in on the next wave of M&A or a rebound in oil prices. Also, adding to the fund’s newfound merit is its cheap 0.29% expense ratio — just $29 per $10,000 invested.
First Trust ISE Revere Natural Gas (FCG)
Another oil ETF choice for investors isn’t actually an oil-focused fund. The First Trust ISE Revere Natural Gas (ETF) (NYSEARCA:FCG) focuses on firms that derive a substantial portion of their revenues from the exploration and production of natural gas. Most natural gas firms also pull out a ton of shale oil and natural gas liquids, making them highly desirable for larger energy producers.
FCG’s portfolio is chock-full of these firms, with the majority of them in the easy-to-digest market cap ranges. And even the ones that aren’t — like Anadarko (NYSE:APC) — have long been rumored to be buyout candidates from the super-majors.
Sure, the ETF has sunk pretty hard as oil and natural gas prices have been routed. But expenses for FCG run just 0.6%, and the rebound is on the horizon.
The Bottom Line: M&A activity in the energy space is rising, and the way to play it is via oil ETFs. Both PSEC and FCG offer the complete package of energy stocks that could be the next targets in buyout activity.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.